A Unified Theory of Macroeconomics
6.1 Introduction
The previous five chapters analyzed some conventional and new macroeconomic theories. The conventional theories have been around for a few centuries, but many new theories have come up since 2007, when the Great Recession led economists and financial writers to question their old models that had failed to see the recession and its severity. There is now a great focus on the effects of income and wealth inequality on macroeconomic performance; some economists look at the effects of environmental pollution on macroeconomic policy, and some others have paid attention to the role of the stock market in macro policy, especially monetary policy.
Readers may have noticed that there are numerous theories about macroeconomic questions, and all seemed to be valid for a while, but were given up when the reality turned out to be different. For a long time, classical and neoclassical models dominated economic policy, but they failed to predict the Great Depression, and were given up after the 1930s. Keynesian economics became popular after the depression but led people to believe that a similar depression could not happen again because the policy makers would use Keynesian measures to prevent it. But the Great Recession has changed that view and the world is still not free completely from its bad effects after more than a decade of using extreme Keynesian policies.
Most people think that no one foresaw the Great Recession coming. For example, Professor Krugman writes: “Few economists saw our current crisis coming, but this predictive failure was the least of the field’s problems. More important was the profession’s blindness to the very possibility of catastrophic failures in a market economy.” But there is one person who foresaw it clearly and even warned about it in a number of books. He is SMU professor and my mentor, Professor Ravi Batra. He wrote a book The New Golden Age in 2006, one year before the recession started. Let us look at some of his published forecasts:
The economy will steadily get worse with home prices falling and layoffs rising . . .
The housing bubble appears to be a major event, which once had a lot of momentum but is now beginning to recede. Its starting point was 2001, when the interest rate started a panicky fall. It is likely to burst in 2008, give or take a year. The burst could start in 2007 and continue till 2009 . . .
The economy could still face a steep recession but avoid the calamity of a depression. Unemployment could rise to the level of 10 percent or more. (pp. 173, 175, 179)
This seems to be an amazing forecast, as if someone had a crystal ball to gaze into the future. We now know that the housing market began to collapse in the middle of 2007, and the NBER said that the recession started in December 2007 and ended in June 2009. Both 2007 and 2009 appear in Professor Batra’s forecast. According to the 2017 Economic Report of the President, the unemployment rate peaked at 10.5 percent in 2010. The figure “10 percent” also appears in this forecast.
Professor Batra also wrote about the future of oil prices:
The oil bubble started in 2003 . . . The current bubble could go on until 2011 and then crash in 2012. (p. 175)
This forecast is slightly off because the oil price stayed above $100 per barrel until 2013 and then collapsed to its 2015 level of around $30 per barrel. In 2017, it averaged around $45.
Professor Batra based his forecasts on a new macroeconomic theory that he called the theory of the wage-productivity gap. I described some parts of this theory in my 2014 book Mass Capitalism: A Blueprint for Economic Revival and later authored two more books in 2015 and 2016 addressing the problems faced by the technological sector of the U.S. economy and offered practical solutions to solve these problems, using the wage-gap theory. Here, I analyze it in full detail, because it appears to offer answers to all the questions that have been raised since 2007 and had not been answered before. It is truly a revolutionary theory. In his 2012 book Economics and Nature, economist Navin Doshi calls it the unified theory of macroeconomics, much like the unified theory of physics. Doshi, like myself, has an engineering degree and frequently writes on current economic problems in a variety of blogs. In Doshi’s words: “Here are some of the events that beg for analysis and understanding.”
- “Why are governments around the world, including USA, sinking in a sea of debt?”
- “Why are American families drowning in debt?”
- “Why did profits surge all over the world in the 2000s, then crashed and then surge again in 2009 and 2010 even as 20 million people remained jobless in the US?”
- “Why are there frequent stock market bubbles and crashes in recent years?”
- “Why do trade deficits and surpluses persist in the globe?”
- “What are the real causes of unemployment, recessions and depressions?”
Is there any theory that can singly analyze all the questions raised above? Fortunately, there is one thesis that rises to this challenge, and that is the theory of the wage gap offered by Professor Batra. (p. 87).
Economics and Nature, written by Doshi in 2012, is a remarkable book itself. It is well written and deals with economic thought since the ancient times, starting as early as 300 BC. Very few books have done that. Doshi concludes: “It is indeed remarkable that what numerous economic schools fail to elucidate is explained by one idea, which may be properly called the unified theory of economics. The unified theory offered by Batra is similar to the grand idea of the unified theory of physics in science.” (p. 88)
A question not appearing in Doshi’s list is this: “Why is there so much income inequality and wealth concentration all over the world?” The wage-gap theory also answers this question.
6.2 The Wage-Gap Theory
Professor Batra first wrote about this theory in his 1999 book, The Crash of the Millennium, in which he predicted a stock-market crash in 2000 and 2001. This crash also happened in the years he predicted. Later he explained it in detail in a 2004 book, Common Sense Macroeconomics, which was revised in 2012. The best version of this theory appeared in his most recent book, End Unemployment Now: How to Eliminate Joblessness, Debt and Poverty Despite Congress, which he wrote in 2015. Here I use his models presented in 2004 and 2015.
Batra begins with a simple or balanced economy, where there is no budget deficit or foreign trade deficit. In equilibrium,
Supply = Demand.
Here macro supply equals real GDP (Y) and
Y = AL,
where A is the average product of labor and L is labor’s employment. This equation is true by definition, because by definition
A = Y/L,
so that productivity (A) is output divided by employment, or output per person. Assuming that all consumption comes only from labor income and savings come from profits,
C = wL,
where C is consumer spending, and w is the real wage. Here wL is the nation’s labor income. This is only a simplifying assumption, but it applies to the U.S. economy, where the rate of savings is extremely low and workers do not have much ability to save. Savings in the economy come mostly from the rich, who earn a lot from their capital investments that bring them profits. Initially, suppose the government sector is very small, there is no budget deficit, and no debt of any type, aggregate demand (AD) can be written as
AD = C + I,
where I is the investment.
Here, AD is macro demand in the absence of any debt.
In equilibrium,
Y = AL = AD.
Let WG be the wage-productivity gap. Then
WG = A/w.
There is also an equation for profits but that will be added later when the analysis examines questions about the stock market. According to Batra, the wage gap is at the center of all macroeconomic phenomena. If the wage gap is low and stable, the economy remains prosperous with no unemployment and little inflation. But if the wage gap rises and stays high, all sorts of problems occur in almost all sectors of the economy. In Common Sense Macroeconomics, Batra writes that a rising wage gap creates troubles:
Why? Because wages are the main source of demand, productivity the main source of supply, and if the two are not in sync with each other, aggregate demand and aggregate supply cannot be in equilibrium for long . . . Whenever any country or region suffered a deep depression, or long term stagnation, you will find the presence of a persistent wage-productivity gap in the background. (p. 202)
There are also equations that Batra uses to explain his theory of the wage gap with the help of numerical examples. Suppose, for the time being, that prices are constant and
w = $6, L = 100, A = $8, and I = $200,
then the real wage is $6, employment is for 100 workers, investment (I) equals $200, and on average a worker produces $8 worth of output. Then
Y = AL =8 x 100 = $800
C = wL = 6 x 100 = $600
and
AD = C+ I = 600 + 200 = $800.
In this example, both AD and AS equal $800, so that market for goods and services is in equilibrium. There is no recession, and no layoffs. But there may not be full employment if labor supply exceeds 100. If labor supply is 110 and 10 people have no job, the unemployment rate is about 9 percent. According to classical and neoclassical economics, if the real wage falls in this situation, unemployment disappears because labor demand goes up when the price of labor falls.
Suppose wage rate falls to $5, but productivity remains constant, so that the wage gap rises from 8/6 to 8/5. Now
Y = $800
C= 5 x 100 = $500
and
AD = 500 + 200 = $700
It is clear that supply now exceeds demand and there is overproduction. Some workers will now be laid off and unemployment will rise. According to Batra,
So you see the classical theory is totally bogus. Instead of solving the problem, this approach makes it worse. In fact, investment will also fall because of a decrease in consumer spending, and more layoffs will follow. (End Unemployment Now, p. 47)
The wage gap also rises if productivity rises but the wage rate remains constant. Suppose productivity value rises to $9 so that a worker produces $9 worth of output. Here again the wage gap rises. Now
Y = 9 x 100 = $900 and AD = $800.
Again, there is overproduction that leads to layoffs. In other words, whenever the wage gap rises, there is overproduction and layoffs follow. It should be clear now that the main cause of unemployment in a market economy is a rise in the wage gap. The cause of the rise in the wage gap will be discussed later.
The assumption of a constant price is not necessary. If the wage gap rises, prices are likely to fall, or inflation might turn into disinflation. In this case, things may get worse because the revenue of employers could fall even more. This is the main reason why central banks have expanded money supply around the world since 2007. They have been constantly worried about maintaining a 2 percent inflation rate because a price fall or disinflation can turn a minor recession into a big one.
A few studies have appeared since 2007 that support the wage-gap theory. I have already referred to the books by Doshi and two economists, Roar Bjonnes and Caroline Hargreaves. In 2017, Thorsteinn Thorgeirsson, Adviser to the Central Bank Governor of Iceland, wrote an article that concluded that the wage gap went up sharply in Iceland before the start of the Great Recession. Iceland was one of the worst-hit nations but has recovered nicely since 2014 as the wage gap fell.
6.3 Wage Gap and the Budget Deficit
Figure 6.1 shows the behavior of productivity and real wages between 1947 and 2013, and it shows the wage gap has been rising sharply since 1980. But the Great Recession did not occur until 2007. What happened to wage-gap theory? The answer lies in the self-interest of the career politicians. In the United States, politicians face elections every 2 years or 4 years. At that time, they are afraid of facing the voters because when unemployment is high, many politicians lose their jobs. Angry voters make politicians nervous. The government then follows Keynesian policies in the interest of the unemployed workers.
Figure 6.1 Growth in productivity and average wage (1947–2013)
Source: Council of Economic Advisers, The Economic Report of the President, 2014.
Politicians or their economic advisers know that layoffs occur because demand is less than supply, and spending must rise to raise employment. The natural way is to follow policies that raise the real wage in proportion to the rise in labor productivity so that demand rises to the level of supply. For example, the government could raise the minimum wage in proportion to the rise in the Consumer Price Index (CPI) and productivity but that has not happened since 1980. The purchasing power of the federal minimum wage was down by more than 30 percent in 2017 compared to its level in 1969.
In addition to happy voters, a career politician also needs money for his election or re-election. He gets this money mostly from the rich people or rich corporations, who do not like to see a rise in the minimum wage. So, he does not want to create angry donors who could deny him the money. The only choice left to the politician is to raise the budget deficit either by raising government spending, or by cutting tax rates, or doing both.
When the Democratic Party is in charge of the government, the budget deficit rises mainly from increased government spending, and when the Republican Party is in charge the deficit rises mainly through a cut in the income tax rate. So, the budget deficit goes up whenever a recession occurs or when unemployment goes up. Since unemployment rises because of a rise in the wage gap, the rising wage gap creates the need for the rise in this deficit.
The needed rise in the deficit can be calculated from the numerical example. For example, in the case of the rise in productivity to $9,
Y =$900.
But,
AD = $800
So that
Over production = Unsold goods = 900 – 800 = $100
This means that the budget deficit (BD) should rise by $100 to close the gap between supply and total spending. This policy is called fiscal expansion, and the government must now borrow this money to finance its new deficit. As a result,
Total spending = C + I + BD = AD + BD
In addition to fiscal expansion, the government acts through its branch of the Federal Reserve because government spending is much smaller than consumer and investment spending. The budget deficit is not enough to raise total spending to the level of supply. So, the Federal Reserve cuts interest rates to persuade consumers to borrow money and spend it, and calls it the policy of monetary expansion or quantitative easing. In this case,
Total borrowing = BD + CB
and
Total spending = AD + BD + CB,
where CB stands for consumer borrowing. For example, if the BD is $30, then CB must be $70 because to eliminate unsold goods
Overproduction = BD + CB
All this borrowing adds to the debt so that
BD + CB = New debt
and in equilibrium
AS = Total spending = AD + New debt
This is Professor Batra’s fundamental equation of macro equilibrium, as shown in Figure 6.2, that explains why there is so much debt in America today. In other words, macro equilibrium nowadays does not mean that
Figure 6.2 Modern representation of a balanced economy
Source: Batra, Ravi. Commonsense Macroeconomics, Cover Page, 2012.
Supply = Demand
It means that
Supply = Demand + New debt,
where demand is money spent by consumers and investors from their incomes, and is different from total spending that includes total borrowing. I interviewed Professor Batra about his fundamental equation and asked him how debt could be a part of the equilibrium condition. He said,
New debt has become a part of equilibrium because the government now acts automatically to raise total spending whenever the spending falls short of the supply of goods and services. The government action is as predictable as that of markets, and so it is now a part of equilibrium. This is what explains why there is enormous debt at all levels in the United States. Consumers, students, federal, state and local governments are all drowning in an ocean of debt. But the main culprit is the rising wage gap along with the desire of most politicians to obtain campaign donations from the ultra-rich 1 percenters.
Batra’s equilibrium equation indeed explains why debt has risen sharply since 1980 and continues to rise. If productivity rises every year and wages remain stagnant, then
Supply > Demand
every year. So, debt must rise every year to create equilibrium. Since productivity rises exponentially, then debt must rise exponentially. According to 2017 Economic Report of the President, productivity more than doubled between 1980 and 2016 while the real wage remained more or less constant. Since wage income is the main source of demand, supply rose much faster than demand and to raise spending to the level of supply, government debt rose every year, and as the Federal Reserve cut interest rates once in a while, consumers also borrowed money again and again. So, by 2017, both government debt and consumer debt, including student debt, broke new records.
The debt was huge even in 2012 when Doshi wrote his book and claimed that the wage-gap theory explains “Why are governments around the world, including USA, sinking in a sea of debt?” The wage gap has risen further since 2012 and so has government debt all over the world.
6.4 Wage Gap and Profits
The third question on Doshi’s list is: “Why did profits surge all over the world in the 2000s, then crashed and then surged again in 2009 and 2010 even as 20 million people remained jobless in the US?” Actually, profits have risen even faster since 2010, while the economy has continued to stagnate. I raised this question in my interview with Professor Batra and his answer to this question simply shocked me. He said, “The federal government as well as the Federal Reserve are making the rich richer than ever before, because when wage gap and debt rise profits sky-rocket. The numerical examples in my books and the data demonstrate this decisively.” He pointed to a graph on page 52 of his latest book, End Unemployment Now. This graph, reproduced as Figure 6.3 here, uses data compiled by New York Times and shows that the rate of profit under the Obama administration was near its all-time high, when the federal debt almost doubled.
Figure 6.3 After-tax corporate profits as share of GDP under various presidents (in %)
Source: Batra, Ravi. End Unemployment Now, p. 52. Other Source: The New York Times, April 4, 2014.
Figure 6.4 conveys a similar idea. This one looks at the rate of profit rather than the share of profit from 1947 to 2011. The wage-gap theory says that there are two main influences on the rate of profit. One is the wage gap and the other is the level of government spending and debt. The 1940s were a war decade during which the government spending and debt went up sharply. The profit rate was also high and it is represented by the 1947 figure of 16 percent. The war had just ended and then the government spending and debt began to fall. By 1950, the profit rate fell to about 14 percent. The wage gap during the 1940s was stable, as the real wage kept pace with productivity (see Figure 6.1). From 1950 to 1970, the wage gap either fell or remained stable, while the war debt was retired. The profit rate also fell steadily. By 1970, it had fallen to a low of 8 percent, which is half of what it was in 1947. Clearly, as the wage gap fell or stabilized, and as the government debt fell, the profit rate also fell, and further fell sharply. From 1980 onward, the wage gap and the government debt began a steady rise. The profit rate hit an all-time high of 19 percent. Clearly, the rising wage gap along with government debt make the rich richer.
Figure 6.4 Rate of profit in selected years (in %): 1947–2011
Source: Batra, Ravi. End Unemployment Now, p. 53 . Other Source: Council of Economic Advisors, The Economic Report of the President, 1975 and 2013.
Professor Batra uses an equation for profits to prove his theory. Economists usually think that capital and labor are the main factors of production so that all production is divided between labor income and profits, which represent income to the owners of capital. In equilibrium,
GDP = Y = Labor Income + Profits
or
Profits = Y – Labor income.
But in disequilibrium when there is overproduction
Profits = Y – Labor income – Unsold goods
This is because the profit of any firm falls by the value of unsold goods. Going back to the numerical example, initial values are
w = $6, L = 100, A = $8, and I = $200.
With the economy in equilibrium initially, unsold goods = 0 and Y = AD = $800, and with
C = wL = $600,
Profits = 800 – 600 = $200.
If productivity rises to $9, and the wage rate is constant, then as explained before, there are unsold goods of $100, so that
Profits = 900 – 600 − 100 = $200
In spite of a rise in productivity, profits do not change because of the presence of unsold goods. But this is the predebt profit income when the economy is in disequilibrium. When monetary and fiscal expansion create new debt of $100 to generate equilibrium with zero unsold goods, then
Profits = 900 – 600 = $300.
Before the debt, the profit is still $200, but in the post-debt equilibrium, when the companies are able to sell their entire production, profits rise to $300. What is more interesting is that profits rise by the full amount of the new debt.
If production goes up and the real wage falls, which happened during the 1980s and from 2007 to 2009, then the wage gap increases sharply, and profits may actually fall because of a big rise in unsold goods, but as soon as the government creates new debt, then profits start to rise and rise enormously. In this case, Prof. Batra writes:
If wL or labor income falls, profits may or may not rise, and may actually decline, because unsold goods then certainly go up. If the government follows a policy of debt creation to absorb unsold goods, then it is clear that profits will rise close to the level of new debt, because then unsold goods fall to zero, unemployment vanishes and wL may stay constant. All this explains why the rate and share of profits neared their all-time high in 2014. (End Unemployment Now, p. 224)
6.5 Inequality and Wealth Concentration
A chapter in the 2017 Economic Report of the President deals with the question of income inequality and wealth concentration in the United States. It starts with the following quote:
In 2013, President Obama declared inequality “the defining challenge of our time. According to the congressional Budget Office (CBO), in that year—the most recent year for which complete data are available—the 20 percent of households with the lowest incomes had an average pre-tax income of $25,000 while the 1 percent of households with the highest incomes had an average income of $1.6 million. Roughly 15 percent of Americans lived in poverty . . .” (p. 151)
On the next page, the report states:
From his first days in office, President Obama has taken important steps to reduce inequality and make the economy work for all Americans. The policy response to the Great Recession directly reduced inequality in after-tax incomes through progressive tax and spending policies, such as temporary tax cuts for working and middle-class families. (p. 152)
President Obama was concerned about the big rise in income inequality and wealth concentration that had occurred during his administration and in previous years, and he tried to reduce this inequality through tax cuts for middle-class families. For the first time, a Keynesian style tax cut had occurred through a temporary fall in the social security tax. But his temporary tax cut made little difference to the huge rise in inequality caused by a jump in consumer and federal debt that occurred through the adoption of Keynesian expansionary policies. As Prof. Batra told me: “This is the biggest problem with neo-Keynesian policies. On the one hand, they create enormous debt at the consumer, state and federal level, and on the other they enrich the rich, and its proponents don’t even realize that their own economic advice hands over vast economic and hence political power to the wealthy. Keynesianism gives pittance to the working families but offers a golden goose to the opulent.”
Neo-Keynesian economists, such as Professors Stiglitz, Krugman, Sachs, and many others, are very critical of the wealthy one percenters for amassing vast amounts of wealth at the expense of the poor and the middle class, but they do not understand that their own advice is mainly responsible for the rise of one percenters. In this connection, two economists, Roar Bjonnes and Caroline Hargreaves, write:
Governments have been printing and borrowing money to stave off a collapse of the economy, but Batra claims that the only people to benefit from the huge budget deficits are the rich.
If there is a wage gap, then more goods are produced than can be bought. In this case, profits may actually fall. According to economist Ravi Batra, If consumer [or government] borrowing absorbs the unsold goods, business revenue rises by the amount of that borrowing and with wage cost staying constant or falling, the entire debt goes into raising profits by the same amount, provided the nation is not in a serious recession. The point is that monopoly capitalists always benefit hugely from so-called monetary and fiscal policies. (pp. 62–63)
Few economists blame American debt for extreme American inequality. Professor Stiglitz, for example, blames it mostly on rent seeking. In an article on this subject, he writes:
Thus, rent seeking means getting an income not as a reward for creating wealth but by grabbing a larger share of the wealth that would have been produced anyway. Indeed, rent seekers typically destroy wealth, as a by-product of their taking away from others. A monopolist who overcharges for her or his product takes money from those whom she or he is overcharging and at the same time destroys value. To get her or his monopoly price, she or he has to restrict production. (evonomics)
Professor Krugman blames inequality on other factors. He writes:
Disposable income in the United States is more unequally distributed than in most other advanced countries. But why?”
. . . The standard story up until now has been that the source of US inequality exceptionalism lies in the unusually low amount of redistribution we do through our tax and transfer system.
. . . We know that the US has unusually weak unions, low minimum wage, an exceptionally wide skills premium and, of course, an exceptionally imperial one percent. Shouldn’t all this leave some mark on market income? (NYT)
The explanations offered by Stiglitz and Krugman are indeed valid, but according to the wage gap theory, they only explain that the wage gap has been rising. They do not explain why both income and wealth disparities have increased enormously even in a stagnant economy since 2007. Inequality cannot rise without a rise in debt. Even during the roaring 1920s, when Keynesian policies were unknown, inequality went up sharply because of the rising wage gap along with a rise in consumer debt. Unless goods produced by the rent seekers of Professor Stiglitz are sold, the producer cannot realize the fruit of the rising wage gap resulting from rising productivity and stagnant wages. And that requires a rise in debt.
6.6 Wage Gap and the Stock Market
Many economists have noticed that traditional macroeconomics does not offer a valid theory of the behavior of the stock market. Professors Stanley Fischer and Robert Merton conclude that “macro analysis should give more attention to the stock market.” Stanford Professor Robert Hall, the president of American Economic Association in 2010, once said that “economists are as perplexed as anyone by the behavior of the stock market.”
According to the wage-gap theory, a rise in the wage gap along with a rise in debt sharply increases the rate of profit. For example, in the numerical example in Section 6.4, when labor productivity rises from $8 to $9, the profit level rises from $200 to $300, provided the debt rises sufficiently so that there are no unsold goods. The rise from 8 to 9 is about 12 percent and a rise from 200 to 300 is 50 percent. In other words, a 12 percent rise in productivity generates a 50 percent rise in profits. Since the share prices are proportional to the level of profits, the stock market rises much faster than a rise in productivity. This is what happened during the dot-dot.com boom in the 1990s and perplexed economists such as Robert Hall. This is also what has happened since 2009 when the NBER declared the end of the Great Recession. People constantly wonder how the stock market breaks records in a stagnant economy. The answer is given by the constantly rising wage gap and the debt.
This is also what happened during the 1920s, when the wage gap rose sharply along with consumer debt (see Figures 6.5 and 6.6).
Figure 6.5 Wage gap, consumer debt, and budget surplus (in %): 1919–1929
Source: Batra, Ravi. End Unemployment Now, p. 69. Other Source: Historical Statistics of the United States, Series D68, D727 and D802.
Figure 6.6 Wage gap and share prices: 1919–1929
Source: Batra, Ravi. End Unemployment Now, p. 70. Other Source: Historical Statistics of the United States, Series X495.
When the wage gap and debt go up for several years, the continuous rise in profits creates a stock-market bubble. A bubble may be defined as the case where people buy more stock even if stock prices rise. Normally, when the price of something rises, people buy less of it. But when people start buying more of some shares even with rising share prices, this means that they begin to take increasing amounts of risk. This creates inflated stock prices and a stock-market bubble is born. But every bubble has crashed in the past. The crashes of 1929, 1987, 2001, and 2008 had one thing in common. They all resulted from the bursting of a stock-market bubble.
The wage-gap theory says that every bubble crashes in the end. The reason comes from Batra’s fundamental equilibrium equation that
Supply = Demand + Consumer borrowing + Government borrowing.
As long as this condition holds, producers are able to sell their output even if productivity rises faster than the real wage. This results in a sharp increase in profits, and when this happens over a long time, a bubble is born and no one expects the bubble to burst. Now the government borrowing can go on indefinitely. But consumer borrowing has a limit because the banks require reasonably good collateral to support their loans. Banks may be prone to taking greater risk in good times, but this cannot go on indefinitely. During the housing boom from 2001 to 2006, banks took big risks in home loans, but they still had some collateral underlying the loans. The collateral came from the value of the house even though some of these houses had inflated prices.
At some point in time, borrowers have used up their good collateral. At this point, banks cut their lending. As consumer borrowing falls,
Supply > Demand + Consumer borrowing + Government borrowing.
In other words, the value of production exceeds total spending and overproduction occurs. This causes a recession, layoffs, and a stock-market crash. Thus, bank lending creates a stock-market bubble and then bank restriction of lending causes a crash. This is how the stock market crashed in 1929 and later in 2008.
Sometimes, politics causes the government to cut its deficit or reduce the money supply. Here again supply exceeds spending to cause a recession and layoffs and eventually a stock-market crash. This is how a crash occurred in 2000 to 2001. Thus, according to the wage-gap theory, a stock-market bubble always bursts in the end.
6.8 Wage Gap and the Trade Surplus
The wage-gap theory also explains why a nation may adopt policies that create a constant trade surplus. This has happened in the case of many Asian countries such as China, Japan, and South Korea. It has also happened in the case of Germany.
As the wage gap rises, supply exceeds demand. Unless the government and consumers borrow enough money to raise spending to the level of supply, there is over production and layoffs. But suppose a nation’s consumers are unwilling to borrow money and go into debt. The rates of savings are very high in China, Japan, and South Korea. Their people do not want to get into the debt habit. These nations then seek to send their excess production abroad, which becomes their trade surplus. In order to maintain a constant trade surplus, they constantly devalue their currencies relative to the dollar. The devaluation may be done openly or through purchase of American assets, especially U.S. government bonds.
With the help of dollars acquired through their trade surplus, the governments of trade surplus nations create artificial demand for the dollar so that the dollar remains an overvalued currency. Thus, the wage-gap theory explains why nations like China and Japan have constant trade surpluses while the United States has constant trade deficits.
6.9 Reasons for the Rising Wage Gap
There are many reasons for the rising wage gap and most of them are well known. Professor Stiglitz has noted some of them and Professor Krugman has written about others. Anything that lowers demand for workers and raises labor supply tends to reduce the real wage and raise productivity. The following are some important reasons for the rising wage gap in the United States:
- Mergers after mergers have occurred in almost all industries. As a result, most industries have become oligopolies with large monopoly power for their dominant firms. The most famous merger is the one between two large oil firms such as Exxon and Mobil that became Exxon-Mobil in 1998. In 1911, they have been formed from the break-up of one company named Esso Oil. But the anti-trust laws are no longer enforced so mergers among large and profitable firms have become common since 1980. Each time a company merges with another, not only competition falls in that industry but also a large number of employees are fired. The result is a rise in productivity and a fall in the real wage. So, the wage gap goes up.
- Another reason is a huge fall in the real minimum wage since 1969. About 20 million workers earn either a minimum wage or have their wages tied to it. The falling minimum wage, along with a rise in productivity, is a big reason for the rise in the wage gap.
- Rising foreign competition is another reason that has lowered the influence and membership of labor unions. With a decline in union power and a rise in monopoly power of companies the wage rate no longer keeps up with rising prices. So, the real wage falls for production and non-supervisory workers, who are more than 75 percent of the labor force.
- The constant trade deficit since 1980 has sharply lowered the importance of manufacturing in the U.S. economy, and manufacturing used to pay higher wages than other sectors such as the government and services.
- Finally, some economists argue that rising productivity resulting from new technology offered by computers, robotics, and so on, lowers the demand for labor relative to labor supply. Thus, productivity rises but the real wage may fall. Such is the argument made by Abel and Bernanke. Many others have made a similar argument. The ultimate result is a rise in the wage gap.
The wage-gap theory does not believe in neo-Keynesian economic policies that call for a rise in government and consumer debt whenever unemployment tends to rise. Such policies are desirable only in an economic emergency like that of the Great Depression or the Great Recession. Keynes never wanted a constant budget deficit. He said that the budget deficit was needed in a serious recession or depression, but once the economy recovered there should be a budget surplus. Thus, there is no need for a balanced budget every year, but the budget should be balanced over the course of the business cycle. Thus, neo-Keynesians have not been good followers of their leader.
The wage-gap theory believes in the policies of Adam Smith. The state should create competition in all industries because competition keeps prices low and wages high. The state should also take care of a nation’s defense and infrastructure. In addition to Smith’s policies, the wage-gap theory also believes that the minimum wage should be large enough so that a worker can afford at least the basic necessities of life such as food, clothing, shelter, education, and health care. This will keep government spending low on welfare.
Unlike Keynesian economics that calls for stabilizing aggregate demand through automatic stabilizers, the wage-gap theory believes in stabilizing the wage gap. The two decades in which this gap was low and stable were the 1950s and the 1960s. In both cases, the U.S. economy grew strongly, and the middle class prospered. During 1950s and 1960s, a family could easily afford the necessities of life such as food, shelter, clothing, education, and health care without going into much debt. Consumer debt was low, and so was the federal debt.
Figures 6.7 and 6.8 illustrate these points graphically. Figure 6.7 shows that during the 1950s, for instance, the wage gap actually fell slightly and the real median income rose sharply and reduced poverty. However, the rate of profit was also low, as shown in Figure 6.8, but still it was adequate to keep the economy close to full employment. The 1950s ended up in a short recession, but the real median income kept rising. So, there is strong evidence of at least two decades that when the wage gap is stable, the middle-class benefits from rising productivity, and the government did not have to resort to debt creation to maintain prosperity.
Figure 6.7 Wage gap and real family income in the 1950s
Source: Batra, Ravi. End Unemployment Now, p. 139. Other Source: Historical Statistics of the United States, Series X495 (* Median Income is also known as real family income).
Figure 6.8 Rate of profit in the 1950s
Source: Batra, Ravi. End Unemployment Now, p. 141. Other Source: Council of Economic Advisers, The Economic Report of the President, 1975.
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